The Credit Crisis Of 2008a

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Background of Credit Crisis

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  • The Credit Crisis Of 2008a

    1. What Happened?
    2. NASDAQ People moved assets from stocks to Housing after the crash of 2000.
    3. Case Schiller Housing Price Index 1890-2008 and prediction Based on past adjustments bottom by 2010 200___ 190___ 180___ 170___ 160___ 150___ 140___
    4.  
    5. Borrower Mortgage Broker Lender Loan $$$ Loans facilitated by Mortgage Brokers who had no continuing Interest Principal Agent Problem
    6. Borrower Mortgage Broker Lender Issuer Investors Credit Rating Underwriter Loan $$$ $$$ Loan Monthly $ Security $$$ Monthly $ Lenders sell their loans to Others to recapitalize and continue Loaning. Issuers bundle loans into securities (Collateralized Debt Obligations) To resale to investors
    7. Spreading the Risk
    8. Some Common Companies Borrower Countrywide FNMA Bear Stearns Goldman Sachs Moody’s Loan $$$ $$$ Loan Monthly $ Security $$$ Monthly $
    9. <ul><li>FNMA: Federal National Mortgage Administration (founded 1938) </li></ul><ul><li>FHLMC: Federal Home Loan Mortgage Corporation (NYSE:FRE)(Founded 1968) </li></ul><ul><li>Private, but “government sponsored” </li></ul><ul><li>Secondary mortgage market </li></ul><ul><li>Bought and resold mortgages from lenders </li></ul><ul><li>Guaranteed security to investors </li></ul>
    10. Security Insurance Insurer Investor Default Protection Security Security Investor’s seek insurance to cover unexpected defaults on loans
    11. Credit Default Swaps Goldman Sachs AIG
    12. <ul><li>Reselling the CDS’s </li></ul><ul><li>Reselling the mortgage </li></ul><ul><li>Reselling the securitized instrument </li></ul>AIG Hedge Fund Sovereign Wealth Fund
    13. The Whole System Borrower Countrywide FNMA Goldman Sachs Loan $$$ $$$ Loan Monthly $ Security $$$ Monthly $ AIG Premium CDS Hedge Fund
    14. What Went Wrong Borrower Countrywide FNMA Goldman Sachs Loan $$$ $$$ Loan Monthly $ Security $$$ Monthly $ Premium CDS Insurance Borrower AIG Hedge Fund Borrower defaults
    15. Multiplied Losses Borrower Countrywide FNMA Goldman Sachs Loan $$$ $$$ Loan Monthly $ Security $$$ Monthly $ Premium CDS Insurance Borrower $1 $1 $1 $1 $1 AIG Hedge Fund
    16. <ul><li>Increase lending (2007) </li></ul><ul><li>Guarantee Bear Stearns’ “value” for purchase by Morgan Stanley (3/08) </li></ul><ul><li>Let Lehman Brother’s collapse (9/15) </li></ul><ul><li>Facilitate Merrill Lynch sale to Bank of America </li></ul><ul><li>AIG—too big to fail (9/16 loan, equity) </li></ul><ul><li>Change Morgan and Goldman to “banks” to access credit (9/21) </li></ul>
    17. <ul><li>Wachovia Bank bought 9/29/08 by Citigroup </li></ul>Balance Sheet as of 6/30/08 <ul><li>Note: </li></ul><ul><li>Banks are illiquid </li></ul><ul><ul><li>Short term liability & long term investment </li></ul></ul>Assets Current $110 b Long term: Investments $600 Other: $100 Total $810 Liabilities Short Term: $505 Long term: $230 Equity: $ 75 Total: $810
    18. <ul><li>Insolvency </li></ul><ul><ul><li>The long term investments (e.g. mortgages) have lost value (at least at short term, market price) </li></ul></ul><ul><ul><li>Plus, no one wants to buy (value declines more) </li></ul></ul>Value of investments for illustration only, unknown value Assets Current $110 b Long term: Investments $500 Other: $100 Total $710 Liabilities Short Term: $505 Long term: $230 Equity: $ 0 Total: $735
    19. <ul><li>Sell Assets </li></ul><ul><ul><li>Citigroup buys bank, covers up to $42b in loss </li></ul></ul><ul><ul><li>FDIC covers amount over $42b </li></ul></ul><ul><ul><ul><li>Gets $12B in stock warrants in Citigroup </li></ul></ul></ul>
    20. <ul><li>Federal Government agencies buy up bad debt that couldn’t be sold. </li></ul><ul><li>This removes bad asset & injects liquidity </li></ul>
    21. <ul><li>Feds Buy Now, Sell Later </li></ul><ul><ul><li>Willingness to buy stabilizes prices </li></ul></ul><ul><ul><li>Some problem loans will be ok </li></ul></ul><ul><ul><li>Net cost = ? </li></ul></ul>
    22. <ul><li>1(a) Authority to Purchase.–The Secretary is authorized to purchase, and to make and fund commitments to purchase, on such terms and conditions as determined by the Secretary, mortgage-related assets from any financial institution having its headquarters in the United States. </li></ul><ul><li>6. The Secretary’s authority to purchase mortgage-related assets under this Act shall be limited to $700,000,000,000 outstanding at any one time </li></ul>
    23. <ul><li>Sec. 8. Review. </li></ul><ul><li>Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency. </li></ul>
    24.  
    25. <ul><li>Government will buy bad debts </li></ul><ul><ul><li>Republicans wanted to just insure </li></ul></ul><ul><li>Limits on Executive pay </li></ul><ul><li>Limited bankruptcy and foreclosure reform </li></ul><ul><ul><li>Democrats wanted to require loan adjustments </li></ul></ul><ul><li>Limits on discretion </li></ul><ul><li>Net loss after 5 years recouped by new taxes on banks </li></ul><ul><li>Disburse in portions, not full $700b. </li></ul><ul><li>New bill=400 pages </li></ul>
    26. <ul><li>Economist Magazine </li></ul><ul><ul><li>www.economist.com </li></ul></ul><ul><li>Wall Street Journal </li></ul><ul><ul><li>www.wsj.com </li></ul></ul>

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